Forgive Us Our Debts?
Forgive Us Our Debts?—No, not our sins, our mortgages: Should those who can't afford their mortgages be helped by the government? Two views.
By Nicole Gelinas
In Edith Wharton's The House of Mirth, tragic young heroine Lily Bart learns that the sum of money she had thought a friend's husband, Gus Trenor, had earned for her through investing her modest savings in the stock market was actually a payment—a payment for which he expected certain favors. Horrified, Miss Bart vows to return the funds, unwavering in this pledge to recover her own honor even through the loss of her expected inheritance and through her spiral out of the upper class into the working class. The last thing Miss Bart does before dying of a drug overdose born of her self-torture is to lay an envelope containing the money owed to Mr. Trenor on her night-table. In Mrs. Wharton's other classic book of Gilded-Age New York, The Age of Innocence, the bankruptcy of financier Julius Beaufort through stock-market speculation gone bad is a society scandal. "To have kept her grandmother's carriage at a defaulter's door!" cries one patriarch of the wayward young woman who defiantly visits Beaufort's distressed wife.
Today, the idea of an unpaid debt as a scarlet sin has vanished. In modern-day New York, Lily would sue Trenor for securities fraud. Beaufort, if his investment firm was big enough, would appeal to the feds for a bailout. If not, he would disappear for a while and then reappear to launch a new hedge fund.
We shouldn't lament the disappearance of the notion that our debts should follow us to the grave and even beyond, disgracing our heirs. Oftentimes, personal bankruptcy is simply a sign of our dynamic economy: People take huge risks with their own savings and credit to start their own businesses, and fail. An entrepreneur who fails once, though, might succeed spectacularly the second time. Our system, more or less, lets him do that; shaming him into oblivion would do an economic and social disservice. In fact, in the venture capital world, investors sometimes view previous failure as a plus; they know that the person in whom they're investing has an idea of his limits. Other times, personal bankruptcy is rooted in healthcare costs—and while some people with overwhelming healthcare bills were irresponsible in not obtaining insurance, others, especially those with preexisting conditions, simply couldn’t get insurance at a price that's affordable, or ran out of it well before their bills ran out.
Of course, we're still ambivalent about default. And as the nation falls deeper out of the burst housing and mortgage bubble, we're sure to see a marked increase in bankruptcy that still carries the greatest stigma—that borne of the most common human fallibility. Between 2002 and 2006, housing prices around the nation more than doubled, and Americans caught up in the gauzy euphoria spent many of those ephemeral profits, turning them into very real debt and future losses.
In 2005, economists Alan Greenspan and James Kennedy have found, Americans borrowed nearly $144 billion by taking equity out of the rising value of their homes to pay off credit-card and other non-mortgage debt, representing nearly 6.5 percent of all such debt outstanding. This figure was more than twice the amount Americans had borrowed from their houses for this purpose just three years earlier, when such debt repayments represented only 3.7 percent of existing consumer credit. Such an easy repayment source, of course, only encouraged more borrowing. At the same time, in 2005, Americans took an additional $183 billion out of their homes for direct spending, up 80 percent from three years earlier.
As housing prices have stopped increasing, Americans no longer have this ready source of funds with which to repay their credit-card debt, even as they are slow to adjust to the change, continuing to borrow. In the states hardest hit by the real-estate bust, credit-card borrowing was up by double-digit percentages earlier this year. And as people realize that their instant stash of debt-repayment cash—that is, the rising value of their homes—has evaporated and will not re-materialize any time soon, more and more will turn, or be forced into, personal bankruptcy.
As bankruptcies mount, we'll have to face our continued ambivalence regarding the defaulted debtor. In fact, we're already doing it. In the July 20 New York Times, reporter Gretchen Morgenson chronicled the story of Diane McLeod, a Pennsylvania woman so deep in mortgage and credit-card debt that she hides her phone in the dishwasher so as to avoid the collectors on the other end of the line. While some of Ms. McLeod's nearly $300,000 in debt is due to medical bills, much of it is due to spending on the home-shopping networks. Ms. McLeod readily admits that while she started such spending supposedly safe in the knowledge that the rising value of her home could get her out of a hole that got too deep, she kept on spending even when she knew that the ability to keep her home, now that it was losing value rather than gaining it, was in peril. While some Times commenters were sympathetic to Ms. McLeod’s plight, just as many were not, insisting that she take personal responsibility for her actions.
But there is necessary personal responsibility, and then there is a life sentence of repaying debt created in a consumer-credit bubble that may no longer exist. Nobody should wish such a fate on Ms. McLeod, or on the hundreds of thousands, even millions, of working-class, middle-class, and affluent debtors who are likely to join her.
Over the next few years, it's likely that American policymakers and bankruptcy judges are going to struggle to find the right balance of how much bubble-era debt to forgive and how much to require borrowers to try to repay in good faith. We certainly don't want anyone, ten years from now, not to be able to afford to send their kids to college because they’re still struggling to repay the credit-card debt behind the big-screen TV they bought when housing prices were at historic levels. Such a policy would hurt our economic recovery.
Further, Americans who think society is merciful toward fellow citizens who made bad decisions are less likely to support new government bailout efforts in addition to the ones we've already seen, and that's a good thing. Such pernicious efforts are only attempts to avoid more housing market declines rather than face up to inevitable pain. Debt forgiveness through the channels that exist for that purpose, including bankruptcy court, is far superior to government bailout, which, besides prolonging our economic pain, would protect creditors from the consequences of the risks that they readily made as well. Credit providers, as the current banking-industry debacle shows, made the same mistake Ms. McLeod did; struggling consumers who think that they’re suffering more harshly than their creditors for the same mistakes won't look kindly toward our economic system.
But while we should forgive some consumer debt, we can't forgive all. We certainly don't want people to think, on a mass scale, that they can simply walk away from any and all obligations rooted in bad decisions. Such normalization of bankruptcy is no better for society than is default shrouded in shame.
It's important that debtors feel at least some responsibility and acute regret at their bad decisions—even as their creditors should, too. Nobody wants more Lily Barts, but nor do we want to continue to ratify a culture of borrowing and lending promiscuity without consequence for borrowers and lenders alike.
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By David M. Abromowitz
As schoolchildren know, the Liberty Bell is inscribed with the words "Proclaim liberty throughout all the land unto all the inhabitants thereof."
Liberty in America is often equated with economic freedom. Constrain one's freedom to make a deal—even a bad deal—some argue, and liberty is diminished. In an era when rampant personal debt has led to widespread ruin, the efficacy of this view of liberty is thrown into sharp relief. Should some people who have made bad deals be forgiven their debts, or are we all better off if instead they face up to foreclosure and the dire circumstances that come with it?
Millions of Americans already have lost their homes through foreclosure in the last several years. With house prices plunging in the worst downturn in forty years, tens of millions of homeowners have lost trillions in personal wealth, and the problems are far from having run their course. Many who fancy themselves conservative free marketers argue that these borrowers made choices, took calculated risks, borrowed beyond their means, and now should live with the consequences. Emblematic of this view was the Report of the President's Economic Advisers last February:
"Policies that attempt to protect market participants from the discipline of the market risk delaying necessary adjustments and creating a potential moral hazard problem by giving lenders and borrowers less incentive to make prudent financial decisions in the future. Markets naturally self-correct, rewarding good strategies and punishing bad ones. In addition, any government actions mitigating the outcomes of risky behavior may create perverse incentives for reckless decisions by borrowers and investors who may come to rely on government interventions."
It is prudent to avoid moral hazard. But perhaps the real moral hazard is abandoning borrowers who are drowning in the current sub-prime debacle. Some portray them as irresponsible. They made bad deals; let them face the consequences. But is someone who was spending 40 percent of her earnings for a mediocre apartment really "reckless" if she decides to opt instead for monthly tax-deductible mortgage interest payments, even taking advantage of "teaser" rates? How could these borrowers have known in 2005 that when adjustable interest rates reset in 2008 they would not be better off paying mortgages rather than facing unpredictable rent increases? Consider the backdrop: More than 90 million Americans pay more than 30 percent of their income for housing. By 2005, roughly 17 million households were spending more than half of their income on housing, a 3.2 million jump from 2001.
When virtually unregulated, fiercely marketed sub-prime mortgage products flooded the market several years ago, it was little wonder that millions of nurses, firefighters, teachers, secretaries, tellers, and janitors felt they were ready to become homeowners. Today, they hardly need the "discipline of the market" to teach them lessons about making better choices next time—if there is a next time. Even if they avoid foreclosure, default and damaged credit mean many won’t get a second chance.
It is true that some borrowers gambled on getting a raise before the teaser interest rate evaporated. Some applicants even lied. But with more than 5 million borrowing households overextended to the point of default or foreclosure, the situation has reached systemic proportions devastating to the broader economy.
Failing to offer debt relief assistance while debating whether sub-prime borrowers or unregulated mortgage companies are most at fault is no more productive than arguing about whether negligent campers or neglected forest clearance practices contributed more to a rapidly spreading wildÂfire—the first order of business is putting out the fire before it consumes more homes.
Moreover, when invoking that portentous term "moral hazard," many look solely at borrowing behavior. But isn't market discipline even more effectively applied to the lenders who promoted high-cost loans to low-capacity borrowers, yet now expect the government (through the foreclosure and debt collection process) to aid them in recovering every dollar possible from their borrowers' assets? Meaningful debt forgiveness for borrowers might best instill greater discipline in lenders and other Wall Street players, some of whom are perhaps already contemplating the next clever "innovation" to sell to consumers.
A purely economic perspective on this crisis, however, does not show us which policies advance our total well-being, spiritual as well as material. Market systems are human creations that should enhance our humanity; human beings should not instead be made to serve an ideal of the perfect market.Those who claim that pure free-market policies are the only way to preserve and promote liberty would do well to consider the rest of the Leviticus verse that completes the Liberty Bell inscription: "It shall be a jubilee unto you; and ye shall return every man unto his possession, and ye shall return every man unto his family."
The biblical Jubilee addressed the relationship between economic prosperity and human dignity. Land had been distributed equitably among the original Israelites—each household had received land of roughly equivalent value. Over time, as market transactions occurred, some families became better at commerce and had more wealth with which to buy land. Eventually distribution would become unequal. The Jubilee mandated that every fifty years, regardless of what the market had produced, land was returned to its original distribution. In this conception, human beings were more stewards than absolute owners. Overturning the consequences of bad bargains freely made during the course of time advanced ethical goals more than strict adherence to contract enforcement. And in this spirit, promoting massive foreclosures rather than encouraging a policy of forgiving is a morally hazardous course for our society.
The Old Testament custom of the sabbatical (the "shmittah")—which required that personal debts be forgiven every seven years—is also relevant today. Time and again, the Jubilee, Sabbatical and other biblical precepts portray property as encumbered by a social obligation that competes with, and usually prevails over, pure economic efficiency.
For example, witness the obligation regarding the farmer to leave the corners of fields "for the poor and stranger," un-harvested, to be picked for free by those in need (Leviticus 19:9-10). It can hardly be ethical to view property as fully under the dominion of individuals (and by extension, corporations) while also finding fault for failing to share some portion of property with those unable to pay the market rate. The Leviticus approach to property is imbued with the notion that people deserve a second chance. The idea that economic affairs should be arranged to afford this second chance—including recovery from bad deals—is not limited to biblical precepts. Unfortunately, however, we see too little evidence of these wise values in our economic policies today.
Bankruptcy, a right enshrined in the Constitution, for centuries has provided an orderly process of reducing or forgiving debts. A path to a fresh start is not only beneficial to a vital and dynamic economy, but also stands in sharp contrast to the debtors' prisons rampant in England and elsewhere into the nineteenth century.
Under the current bankruptcy rules, however, Donald Trump can file for bankruptcy for large real estate ventures that have freely borrowed money and then force lenders to write down the debt through the "cramdown" (which affords an opportunity to reorganize). Dana Trump, on the other hand, who buys a house and gets into trouble, cannot modify or write down her personal home mortgage debt.
If we accept that collectively we are better off morally and economically with speeding recovery from the current crisis through avenues of forgiveness, many practical actions are possible. The recently enacted housing legislation contains some important features—such as offering borrowers a long-term fixed rate federally insured mortgage refinancing option if the lender agrees to a partial loan write-down. (Yet even this program is voluntary for lenders.)
A change in bankruptcy laws to even the playing field for borrowers, or a change in the tax laws that benefit the large pools of mortgages (known as Real Estate Mortgage Investment Conduits) to penalize them for failing to move defaulted loans off their books after some period of time, may be necessary to spur widespread alternatives to foreclosures.
The wisdom of centuries, that our society does better when it provides a path to a second chance and a new start, is profound. What better time to see its embrace of forgiveness as a path that benefits all of us applied than in today's economic earthquake, before the aftershocks do still more damage?
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This piece originally appeared in In Character
This piece originally appeared in In Character